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Ask The Analyst, Sunday, 12/07/2003

Generating new trading ideas
By Jeff Bailey

Can you give me some guidance in scanning for short-term (five to ten day) trade possibilities? How do you come up with your ideas?

While I've been spending more time trying to cover the indices in the Market Monitor at OptionInvestor.net and haven't had the opportunity to profile as many individual stocks trades, there are several ways I generate trading ideas.

Since I don't have a lot of time to really poor through the fundamentals of a company, and I do believe fundamentals are important, one great way to generate a list of investment/trading ideas is to simply listen to a reputable investment show. For instance, tonight, while I was updating the Pivot Analysis Matrix for this week's trade, I was listening to CNBC's Luis Rukeyser program, where the show's featured guest was Lawrence Auriana. You may recognize his name as he and his partner Hans Utsch, have managed the Federated Kaufmann fund (KAUFX) since 1986.

In tonight's (Friday's) show, guest host Maria Bartiromo asked Mr. Auriana what his favorite top 4 picks were right now.

Now, I'm figuring that Mr. Auriana and his partner, along with a their staff of analysts spend quite a bit of time poring over a company's financials. In fact, Mr. Auriana said the Kaufmann Fund doesn't invest in a company without first meeting with a company's management, and visiting various business locations. While Mr. Auriana admits there will always be the occasional unpleasant "surprise" that even his analysis or research on one of their holding was unable to uncover, I figure Mr. Auriana's shop is probably on top of things, and may have a better idea than I of a company's fundamentals, the either he, or his mutual fund owns.

With that said, I'll listed to an investment manager, and if what he says makes sense, and sounds interesting, here's what I'll do.

The first thing I'll do is pull up a point and figure chart of the stock.

The second thing I'll do is calculate the bullish vertical count (the bearish count if the analysts says he/she is shorting it), and see if the current level of trade, compared to the vertical count and technicals makes sense for the stock to go on my "watch list."

If a stock does look/sound interesting, and the supply/demand chart (point and figure chart) looks to CONFIRM what the analysts said, then I begin the process of establishing action points. Where the third step is to identify a PULLBACK level to buy the stock, but also a BREAKOUT level to buy the stock, if demand for the stock's shares is simply too strong that the stock doesn't pull in to my entry point. Once these two levels are identified, I will set both the downside alert (pullback) and upside alert (breakout trigger) on my QCharts trading software.

The four stocks Mr. Auriana said he likes from the buy side (and explained each one briefly as to why) were Advanced Auto Parts (NYSE:AAP) $80.72, Central European Media (NASDAQ:CETV) $16.30 +0.74%, Orthofix Intl. (NASDAQ:OFIX) $42.71 -2.44% and Dyax Corp. (NASDAQ:DYAX) $6.19 +0.97%.

I should note that Mr. Auriana said some stocks in his mutual fund have been held for over 8 years. While this is truly a longer-term investment style of management, later on I'm going to get you in the mindset of how these fund managers buy stocks.

I'm going to quickly run through my thinking on both of the above stocks, by simply looking at a point and figure chart. I'm not going to show the charts here, as I've come up with a very interesting observation yet to come, but you can follow along by going to www.stockcharts.com and pull up FREE point and figure charts as it relates to these four stocks.

Advanced Auto Parts (NYSE:AAP) $80.72 : AAP's point and figure chart has been BULLISH since April (red 4 on PnF chart) when the stock broke above its longer-term bearish resistance trend at $49.00. After giving a double bottom sell signal in June (red 6 on a PnF chart) at 58, the stock slipped lower to $57, but in early July (red 7) gave a triple top buy signal at $63.00, where the column of X from $58 to $69 built the current bullish vertical count to $94.00. Hmmm... in October (red A) the stock generated the bullish triangle pattern when it traded $75.00. This stock certainly looks bullish. Just for fun, I like to then go to my Qcharts trade station, and use the technique we've taught where I take the retracement tool, anchor at a low (how about the March low at $36.99, and then take the other end of retracement (100%) and attach it to the bullish vertical count target of $94.00. Hmmm.... look at that! I've got to show you this.

Advanced Auto Parts (NYSE:AAP) Chart - Daily Intervals

Hmmm... this unconventional use of retracement where we anchor the bottom and attach to the bullish vertical count does show some tie to AAP's bar chart 38.2%, 50% and recent 80.9% retracement. See that little dip back under the 38.2% retracement? That's the double-bottom sell signal on the PnF chart. There's an old PnF saying that "the first sell signal in the upward trend is a buying opportunity." What should we have been doing after that double bottom sell signal? How about setting an upside alert at $63 for the triple-top buy signal?

I'm setting two alerts on my QCharts trading software. One will actually be set for a pullback alert at $78.00, I want to be alert at that level (Monday, maybe a week from now), and the other alert will be set at a new 52-week high trade of $83.65. If the stock is going to $94.00, which is the BETTER entry point? We'll ask Mr. Auriana that question in a moment, as I'm going to try and show you how Mr. Auriana buys stocks.

There, that was pretty quick. I'd also slap a quick retracement bracket on this chart from that little "sell signal" low of $56.80 and attack the upper end to $94.00 (see the $80.00 support at 61.8% retracement?) and using the same lower anchor point of $56.80, use the "fitted retracement" technique you learned in the July 6, 2003 Ask the Analyst column "Fibonacci retracement. Fit it or stack it!" and by performing a "fit" on AAP, I come up with a 100% retracement at $89.40, where the 80.9% ties wonderfully to Wednesday's close, the 61.8% matches nicely with that little gap lower to $76.94, where the gap lower stopped dead in its tracks as if some "level" were being traded as support. This one sure looks good.

Central European Media (NASDAQ:CETV) $16.30 : This is the Kaufmann fund's largest small cap holding. Bullish vertical count is $11.75. Stop... not interested at this point. Make no mistake, this stock looks like a bull in a china closet, but tough to assess a bullish target. Goodness me, look at that spread-triple top last December at $5.50. Stock recently gave another triple-top at $17.50, traded $18.50, but is now pulling back. I'll bet you dimes-to-doughnuts Mr. Auriana is a buyer at $15.50 though. More on this thought in a minute.

Orthofix Intl. (NASDAQ:OFIX) $42.71 : Hey, a bullish vertical count of $61.00. I'm interested, but need to do some work with retracement. Look at that spread triple-top buy signal at $37.00! Oh yes... I took a retracement from $23.69 (the March 24 relative low) and place top at $61.00. I can see OFIX at $61. Look at the way the bar chart ties in with 19.1% retracement of $30.83 (August pullback)and 38.2% $38.00 (October relative high). Setting downside alert at $40.00 (21-day and 50-day SMA $39 and $38) and upside alert at $45.50 (new 52-week high).

Dyax Corporation (NASDAQ:DYAX) $6.19 : Oh my! Stock gave a triple-top buy signal and broke above its longer-term bearish resistance trend at $4.50 in early September (red 9) and ran to $7.50, pulled back to $5.00, ran back up to $7.50, and now pulled all the way back to $4.50 (gave a double bottom sell signal at $4.75, fell another 25 cents to $4.50 (the first sell signal in the upward trend was $4.75) came close to testing its bullish support trend (first test of bullish support can be painful for the bears as institutions are often lurking nearby) and has now reversed up 4-boxes to $6.00. If the stock trades $8.00, then that's a triple-top buy signal and would then have a bullish vertical count of $16.00 being construction. Oooooo... very tight consolidation in the bar chart and hugging that 50-day SMA as support. Upside alert at $6.30 for a partial position (no bullish count at this point) and pullback alert at $4.75, which would have the stock's PnF chart sitting right on the bullish support trend.

Wow! The MARKET seems to agree with 4 of Mr. Auriana's "top picks."

Now lets have some fun, but also try and learn just how Mr. Auriana and most fund managers buy stocks. Check this out!

I was looking for some info on Mr. Auriana, and found a bunch of inside trades he was making on a stock. Aha! He's dumping one of the stocks he mentioned tonight, while pumping it on Luis Rukeyser's program!

Gulp! No he isn't, he's been buying Mediware Information Systems (NASDAQ:MEDW) $15.96 since January 31, 2001!

Check this insider trading report out, which I found at Yahoo! Finance. http://biz.yahoo.com/t/09/44.html

Now... let's look at a PnF chart of MEDW, and try to see if we can't figure out just how Mr. Auriana builds a position.

MEDIWARE Information Systems (MEDW) - $0.25 & $0.50 box

If there was ever a perfect example of how in institutional investor builds a position, and even "builds a chart" on a stock, then Mr. Auriana's SEC filings where I've circles his various bullish entry points is that example.

I really mucked the chart up, but look at all the triple-top buy signals on this chart, starting back in September of 2000 at $3.50 per share when MEDW also broke above its bearish resistance trend. Maybe Mr. Auriana only buys stocks above trend? While he missed two triple-top buy signal entry points, he made his first purchase at $5.88 (per the filings) on January 31, 2002.

Then, Mr. Auriana, who is a MEDW director, exercised options worth 5,000 shares on June 28, 2002, after the stock had pulled back to $7.00.

Hmmmm, that sell signal at $6.50 negated the prior bullish vertical count of $9.25 (Oh... stock already achieved the bullish vertical count when it traded $9.50) but what that first sell signal in the upward trend probably did is shake out some weak holders (that's OK, just recognize what happened) and then allowed for a new bullish vertical count (X's from $7.00 to $11.00) to then have MEDW's PnF chart building a new count to $20.50.

Shoot! Mr. Auriana missed another triple-top buy signal at $9.00. Oh well... wait for the pullback, then pick up another 15,000, where on three consecutive days, Mr. Auriana buys 5,000 each day. What probably took place this day is some type of crossing of shares. Mr. Auriana's trader on the phone, with another trader, whose client is a seller. Mr. Auriana probably knows better than anyone where the stock is headed and becomes a more aggressive buyer. He may also have wanted to "build the chart" and keep it looking bullish.

Hmmmm... February 3rd rolls around and evidently supply (O's on a PnF chart) of stock begins to dry up, and Mr. Auriana snaps up another 5,000. Do you think Mr. Auriana knows something?

Shoot! Mr. Auriana missed another triple-top buy signal at $11.50. Well, I guess not, he was loading the boat in late January and early February at lower price levels.

Now what is he doing? On October 28th, Mr. Auriana is back at it again. Takes down another 5,000 shares between $14.00 and $14.10.

Do you kind of see how Mr. Auriana seems to be "working" the stock higher, buying on pullback, while perhaps at times, when stock price was much lower, where SMART MONEY knew of an eventual outcome, was willing to take partial positions, but get some exposure to the stock early in the game?

Now... how crazy is it to actually anchor the base of a retracement bracket to the bottom of a stock's bar chart, and attach the upper end to the bullish vertical count?

While the following bar char of MEDW is shown with weekly interval bars, a swing trader could also think of the bars as daily interval bars. With MEDW trading a new 52-week high today, where's upside resistance and where's support? If Mr. Auriana remains bullish on the stock, where is he most likely to be a buyer? Do you see where were going? We're trying to get inside the mind of Mr. Auriana, an institutional money manager, figure out what he has been doing, and more importantly, try to figure out what he IS GOING TO BE DOING if he's still bullish the stock, and we would want to try and join him. He's been "right" so far.

MEDIWARE Information Systems (MEDW) - Weekly Intervals

I've really like looking at a stocks chart on both a point and figure basis and bar chart. I've pointed to the often-times powerful and high probability bullish patterns of the point and figure chart known as the triple-top buy signal. Those weekly bars show some 10% moves taking place in a single week!

If you were a market maker in the stock, how is your inventory looking with the stock at a 52-week high? You're probably a little light in inventory, and having to short to the market to provide liquidity. Where are YOU and perhaps Mr. Auriana going to be battling for stock? Where to you think an everyday investor/trader like you and I might be looking to pick up some shares of MEDW with a current upside target of $16.75?

While MEDW is a thinly traded stock (only 139,000 shares this week) and may not be the best type of stock to try and trade, I thought by showing you how Mr. Auriana, an institutional investor, buys a stock, and how we can match his buying from the SEC filings to how the stock was trading, what kinds of signals it was giving, and where Mr. Auriana chooses entry points (on the PnF chart) served as a good example as to....

Listening to an institutional money manager and his/her thoughts on what stocks they are buying or sometimes shorting....

then use their ideas to match against the technicals.....

then have an understanding of how an institutional money manager will go about building a position as long as they continue to view the stock attractive.

While any "buy side" money manager that buys stock is not necessarily the MARKET, its this kind of money we want to try and follow, get in front of, or try and use their buying power to drive our trades higher.

Mr. Auriana and his Kaufmann fund couldn't really do anything about the market's decline past years as he is supposed to invest his shareholders money in stocks. However, we as traders will try and get inside the mind of the institutional investor/trader, try and figure out where he/she is buying and perhaps selling, to also choose our entry and exit points.

While I went a lot further than what the trader actually asked for, it was by pure accident that I ran across Mr. Auriana's SEC filings, but what a great accident to have happen.

Here's an article I stumbled across on Mr. Auriana.
http://www.neco.org/awards/recipients/leauriana.html

Jeff Bailey


DISCLAIMER:
This column is an information service only. The information provided herein is not to be construed as an offer to buy or sell securities of any kind. The Ask the Analyst picks are not to be considered a recommendation of any stock or option but an information resource to aid the investor in making an informed decision regarding trading in options. It is possible at this or some subsequent date, the editor and staff of The Option Investor Newsletter may own, buy or sell securities presented. All investors should consult a qualified professional before trading in any security. The information provided has been obtained from sources deemed reliable, but is not guaranteed as to its accuracy.

 

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